Risk, Fear, and Money

Hello Readers!

Today I’d like to address one of our biggest fears when it comes to money - the fear of losing it.

We have been trained, through many years of schooling, to become risk averse. The most common path is to study hard, get a good and stable job, ideally as an engineer or doctor, and you’ll be set for life. We are never taught what risk is, how to take risk, and most importantly - how to manage risk.

(for a quick intro to investing, you can go through the previous blog titled Let’s Talk Investing)

What is risk?

I’ll share my understanding of risk. Any kind of change that is irreversible, and the outcome of it is potentially negative. It’s a ‘potentially’ negative outcome that we cannot turn back from. Let’s take an example of a bet:

Mukesh has 10 lakh rupees takes a 1 lakh rupee bet and loses. They have lost 1 lakh rupees.

Anil has 20,000 rupees and bets the whole thing but loses. They have lost 20,000 rupees.

Outcome:

Mukesh lost 5 times as much as Anil.

Still, Anil’s outcome was much worse because Anil lost all his money.

This takes Anil out of the game completely (an irreversible negative scenario).

But Mukesh needs to generate only an 11% return on his leftover capital of 9 lakhs to come back to where he initially was.

Another illustration for this could be something like tendonitis or carpel tunnel syndrome for musicians. If the injury is not taken care of immediately with sufficient rest and recovery, it can become severe and irreversible. An example of this would be Lang Lang’s hand injury a few years ago. Luckily he went to therapy and made a recovery, but for those few years from 2017, he didn’t perform and if he had, it might have cost him his performance career.

The key phrase when trying to understand risk is “an irreversible change with a potentially negative outcome”. That is what we must learn to manage.

How do we approach Risk?

We do not engage rationally with risk regularly. We have an emotional response and that’s when mistakes are made.

You can even try this yourself: try and remember the last time you had an incident related to money. Did someone call to try and scam you? Did you feel uncomfortable when a fast-talking bank salesperson tried to sell you investment schemes? Do you feel happy when your monthly paycheck arrives in your account? When this paycheck arrived, did you feel like splurging or buying a gift for yourself?

How rationally were you thinking in that moment? Be honest with yourselves here! I’ll admit I have done this. When I came by some extra money (a small bonus), I instantly ordered a Polaroid camera which I had been eyeing for a few months. I ended up returning it two days later for a partial refund.

Risk when investing

I’d like to share Gulaq’s risk calculator with you. It’s a short, quick quiz that can profile your risk appetite when it comes to money. Please do take this quiz first so that when you start investing, the volatility of the markets doesn’t worry you.

So the way we manage risk when investing is through diversification. Meaning we won’t put all our money in the stock market, or gold, or fixed deposits, and so on.

As this blog moves forward, we’ll also build up a set of rules to follow so that the role of emotions can be reduced when making financial decisions.